Daily Comment (October 28, 2022)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment summarizes yesterday’s GDP report, including how it may impact U.S. monetary policy. Next, we review why central banks are hesitant to totally remove their policy accommodations as the world heads into recession. We end the report with a discussion about how countries are adapting to a more uncertain world.

 It Isn’t All Good: Don’t be fooled by Thursday’s Gross Domestic Product (GDP) report; a recession may still be on the horizon.

  • The U.S. economy expanded at an annualized rate of 2.6% in Q3 2022. The growth exceeded the Bloomberg consensus estimate of 2.4% and ended a two-quarter streak of economic contractions. Most of the positive news came from net exports, which benefited from a decline in imports and an increase in exports. That said, there were concerns about the GDP data. Personal consumption slowed in the quarter, while residential investment contracted in the same period. The poor performance in the two areas suggests that higher interest rates are slowing the economy.

  • Equities rallied initially after the GDP report was released; however, the S&P 500 and NASDAQ indexes dipped after another day of disappointing earnings. The brief optimism was related to a sigh of relief from the market that the economy was not in recession. That said, company earnings indicate that the country isn’t far from one. Earlier this month, the Conference Board U.S. Recession Probability Model showed a 96% chance of an economic downturn within the next 12 months. Although the latest GDP figure does not eliminate the possibility of an imminent recession, it does mean that the economy is more resilient than previously thought.
  • The positive employment and GDP reports will likely encourage the Federal Reserve to be aggressive in its next two meetings. Although employment numbers have not been officially released, estimates show that U.S. firms added 200k workers to their payrolls in October. Assuming the employment numbers are in the ballpark, the Fed could raise rates higher than most investors are anticipating leading into the end of the year. Hence, we have yet to rule out the possibility of another 150 bps hikes over the last two meetings of 2022. As long as inflation remains elevated, the Fed will try to push rates as high as possible before the economy enters into a recession.

 Central Banks Won’t Commit: Policymakers are reluctant to ditch their monetary-easing tools as they seek to fight inflation and promote growth.

  • The European Central Bank is sending mixed signals to the market about its commitment to fighting inflation. The ECB hiked rates by 75 bps, scaled back support for banks, and maintained quantitative easing. The last of the three measures likely fueled Thursday’s sell-off of the euro as investors worried that the bank will not be able to restore price stability to the Eurozone. Additionally, it is widely speculated that the ECB may scale back the rate hikes. The bank’s lack of aggressiveness could mean inflation will likely stay elevated for longer.
  • There is no backing down in Japan as the Bank of Japan maintained its ultra-accommodative monetary policy and plans to increase the frequency of bond purchases next month. The central bank’s refusal to cave to pressure to tighten monetary policy has led to a sell-off in the yen. Additionally, Prime Minister Fumio Kishida proposed a $199 billion stimulus package. The country’s yield-curve control policy will likely shield the government from rising borrowing costs; however, a depreciating yen should add to inflation, especially as the country continues to import commodities.
  • Central banks’ wariness to abandon bond-buying programs is related to concerns about debt markets. A lack of intervention from the ECB could lead to fragmentation, while Japan’s heavy government debt burden requires its central banks to manage bond yields. These banks’ unwillingness to fully commit to tightening has led investors to seek haven in the U.S. dollar. Thus, we can see the greenback’s strengthening continuing into next year as investors seek refuge in the dollar due to the Federal Reserve’s hawkishness, the slowing global economy, and the war in Europe.

Global Chess: Countries have shifted their priorities as they prepare for a world that is more hostile and less friendly to globalization.

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